Introduction
The Altman Z-Score is a formula that was created way back in 1968 by a financial researcher named Edward Altman. It’s basically a bankruptcy prediction tool that looks at five key financial ratios of a company and gives a single score. If that score is too low, it means the company is likely heading towards financial trouble. But here’s the real question that interests us as Indian investors: did this model actually work for famous Indian corporate failures? Could it have warned us about Kingfisher Airlines and DHFL (Dewan Housing Finance Limited) before they collapsed?
The surprising answer is yes – the Altman Z-Score flagged both these companies as distressed, and sometimes even years before their actual collapse. But the even more important question is: why didn’t anyone listen?
How the Altman Z-Score Formula Works
Before diving into Kingfisher and DHFL, you need to understand how this score is calculated.
The formula uses five financial ratios multiplied by specific weights. For a comprehensive overview of the model, including its history and interpretations, refer to my detailed guide on the Altman Z-Score.
Z = 1.2 * CACLTA + 1.4 * RETA + 3.3 * EBITTA + 0.6 * MPATTL + 1.0 * TRTA.
Where:
- CACLTA = Working capital / by total assets
- RETA = Retained earnings / total assets
- EBITTA = Operating Profit / total assets
- MCAPTL = Market value of equity over total liabilities
- TRTA = Sales over total assets
The interpretation is straightforward:
- Z-Score above 2.99: Company is safe – low bankruptcy risk
- Z-Score between 1.81 and 2.99: Grey zone – moderate concern
- Z-Score below 1.81: Distress zone – high bankruptcy risk
Think of it like a credit health report card. Just like a doctor checks your blood pressure, sugar levels, and cholesterol to diagnose health problems, this score checks different financial health indicators.
Kingfisher Airlines – Distress Signal From 2008 Onwards
Kingfisher Airlines started as a premium airline in India in 2005. It was backed by Vijay Mallya, the founder of Kingfisher beer.
For a few years, Kingfisher looked like a success story. But beneath the fancy brand and luxury flying experience, something was seriously wrong with the finances.
The Z-Score Numbers of Kingfisher Airlines
Multiple research studies that calculated the Altman Z-Score for Kingfisher showed alarming numbers:
- 2008-09: Z-Score = -2.14 (deep distress)
- 2009-10: Z-Score = -1.17 (still heavily distressed)
- 2010-11: Z-Score = -0.27 (continued distress)
- Average Z-Score from 2005-2012: -3.43 (versus IndiGo’s 2.38 in the safe zone)
These aren’t borderline numbers. These are screaming red flags. A score of -3.43 is not just in the distress zone – it’s gone past distress into the danger zone. It’s like a patient whose blood pressure reading is 220/140.
This didn’t happen overnight either. As early as 2008, the company was showing these warning signs.
What Was Actually Wrong?
Looking at the individual components of the Z-Score calculation reveals the specific problems:
- Working Capital Ratio: Kingfisher had negative working capital in every single year from 2010 to 2013. This means it had more current liabilities (money it had to pay soon) than current assets (cash it actually had in its wallet). By 2013, this ratio was -2.83. This is a serious liquidity problem. Since then, Kingfisher couldn’t pay its even short-term bills.
- Retained Earnings Ratio: The company had massive accumulated losses. The ratio was -0.57 in 2010 and collapsed to -5.70 by 2013. This tells us that over the years, Kingfisher had lost far more money than it had ever made. There was no profit buffer to absorb any shock.
- EBIT to Assets Ratio: This was negative in all years. The airline wasn’t making money from its core operations. It was only burning cash.
The Timeline and What Actually Happened:
The model’s predictions and real-world events aligned perfectly:
- 2008-2011: Z-Score remained deeply negative. During this period, Kingfisher started accumulating massive debt (over Rs 9,000 crore by 2011), made huge losses, and had constant cash flow problems.
- March 2012: Kingfisher’s license was suspended, and the airline shut down operations. This is exactly what the -3.43 Z-Score had been predicting for years.
- 2016: The license was finally cancelled.
The research report in 2013 analyzed Kingfisher’s data from 2005 to 2012 and concluded: “The results showed up the poor financial health of the Kingfisher Airlines.” It confirmed that the airline “was on the verge of bankruptcy.”
Another study in 2020 found that the entire Indian aviation sector (except IndiGo) was in financial distress according to the Z-Score model.
Why Nobody Acted on This Warning:
Multiple academic papers and researchers pointed out these Z-Score red flags from 2008-2012. But the regulatory bodies like RBI, SEBI, and MCA seemed to overlook these clear financial distress signals. As a result, banks kept lending to Kingfisher even as the Z-Score kept screaming danger.
It wasn’t until the damage was catastrophic that licenses were suspended and operations shut down.
DHFL: The Housing Finance Company That Imploded
Now let’s look at a more recent example of DHFL.
DHFL was supposed to be a stable housing finance company providing affordable loans to people in smaller cities and towns across India.
The Crisis Timeline:
- September 2018: The IL&FS crisis. It was another major Indian company default. When ILF&S defaulted, it triggered panic in the NBFC sector. Mutual funds like DSP started dumping DHFL papers at 11% discounts (read here), signaling serious trouble.
- January 2019: An investigative journalist portal alleged that DHFL had funneled Rs 31,000 crore through shell companies linked to its promoters (read here).
- May 2019: Credit rating agencies started downgrading DHFL. CARE downgraded the Fixed Deposit program from ‘A’ to ‘BBB-‘. Multiple agencies downgraded commercial papers of DHFL to ‘D’ (Default).
- June 2019: DHFL stopped accepting fixed deposits and delayed interest payments.
- December 2019: The NCLT (National Company Law Tribunal) admitted DHFL for bankruptcy proceedings.
The Z-Score Numbers of DHFL
According to research studies that applied the Altman Z-Score and other bankruptcy prediction models to DHFL:
- Z-Score in 2019: 0.625 (severely distressed)
A score of 0.625 is well below the 1.81 distress threshold. Any score below 1.10 indicates extreme vulnerability to bankruptcy.
What Was Actually Wrong at DHFL:
Just like Kingfisher, DHFL’s problems showed up clearly in its financial ratios:
(a) Asset-Liability Mismatch: DHFL was borrowing short-term money (through commercial papers and inter-corporate deposits) to fund long-term housing loans. This is a classic banking structure problem. When short-term borrowing dried up after the IL&FS crisis, DHFL couldn’t refinance its debt.
Let me explain this more clearly using a hypothetical example.
Imagine you need Rs. 100 to pay your rent every month. But you only have Rs. 50 in your pocket right now. So you borrow Rs. 50 from your friend, but you make a deal that he can ask for it back after 1 month. Now, every time he asks for the money back before you can earn more, you borrow Rs 50 from another friend to pay back the first friend.
This works fine as long as your friends keep lending to you. But what happens when your friends hear that someone else (IL&FS) couldn’t pay back their debts? Suddenly, all your friends get scared and refuse to lend you any more money.
When your first friend asks for Rs 50 back, you have no one to borrow from. You’re stuck.
That’s exactly what happened to DHFL. They were constantly borrowing short-term money that they had to return quickly. This way, they were betting that they could always borrow again when the old loans came due. But when IL&FS defaulted, everyone in the lending world panicked and stopped lending to NBFCs like DHFL.
(b) Liquidity Crunch: From April 11, 2019 to April 30, 2019 (just 19 days), DHFL’s liquidity buffer dropped from Rs 3,982 crore to Rs 2,775 crore. The company was hemorrhaging cash.
In these 19 days, DHFL lost Rs 1,207 crore from its cash reserves. This massive cash burn in such a short time showed DHFL was desperately running out of money and couldn’t survive much longer without finding new funding.
(c) Loan Quality Issues: The auditors flagged deficiencies in loan documentation for Rs 20,750 crore of loans and uncollected cheques worth Rs 16,000 crore.
DHFL’s auditors discovered huge problems. Rs 20,750 crore worth of loans had missing or incomplete paperwork. There were no proper documents to prove the loans were real. Also, Rs 16,000 crore in cheques from borrowers hadn’t been collected or deposited.
This meant DHFL couldn’t prove it actually had those loans, and it wasn’t even collecting money that borrowers owed. It was a massive red flag for a lending company’s health.
(d) Fraud Allegations: Rs 31,000 crore of loans were allegedly siphoned off to shell companies with links to the promoters.
Comparing to IndiGo (The Success Story):
To show the contrast, IndiGo Airlines in the same period had a Z-Score of 2.38 (safe zone).
Its working capital to assets ratio was 0.27 (positive), while Kingfisher’s was -1.03 (negative).
IndiGo’s long-term debt to total assets ratio was 0.56, while Kingfisher’s was 1.22 (way above the safe level of 0.5).
These numbers explain why IndiGo survived while Kingfisher collapsed.
Did the Z-Score Actually Work?
Yes, But With Caveats
The Altman Z-Score successfully predicted both Kingfisher and DHFL’s financial distress. But success in prediction doesn’t mean success in prevention. Here’s why:
Where the Z-Score Worked:
- Early Warning: Both companies showed distress signals years before actual collapse. Kingfisher’s Z-Score was negative from 2008, but the airline didn’t shut down until 2012. DHFL’s problems became visible in 2019, and the bankruptcy petition was admitted in December 2019.
- Accuracy: Research studies have found that the Altman Z-Score model has an accuracy rate of 92.5% in predicting bankruptcy one year before it occurs, and 77.5% accuracy two years in advance.
- Consistent Indicators: Once a company entered the distress zone, it stayed there. There was no temporary dip followed by recovery. Both Kingfisher and DHFL’s scores consistently worsened.
Where the Z-Score Had Limitations:
- Timing Uncertainty: The model tells you a company is likely to fail, but not exactly when. Kingfisher’s Z-Score was terrible from 2008, but it took 4 years to actually fail. For short-term investors, this is crucial – a company can appear “about to fail” for years before it actually does.
- External Shocks: The model is based on historical financial data. DHFL’s crisis accelerated dramatically after the IL&FS collapse in September 2018. While the model would have shown distress, the speed and severity of the collapse might have surprised people.
- Fraud Factor: In DHFL’s case, the fraud allegations (Rs 31,000 crore siphoned off) were not immediately visible in the financial statements. The accounting numbers looked bad, but not as terrible as the actual situation. The Z-Score would have flagged distress, but not the full extent of the fraud.
- Regulatory and Policy Responses: The Z-Score doesn’t account for government intervention or policy changes. A government could theoretically bail out a company or provide emergency liquidity, turning a bankruptcy signal into a survival story.
Why Didn’t Regulators and Banks Act on These Signals?
This is perhaps the most important question for us as investors.
If academics and researchers could see these Z-Score warning signs, why didn’t banks, rating agencies, and regulators act sooner?
The Kingfisher Story:
Multiple papers documented Kingfisher’s Z-Score problems as early as 2008-2009. Yet, banks like SBI, IDBI, PNB, and others kept lending to Kingfisher. They nearly got exposed to about Rs 9,000 crore.
It wasn’t until 2012 that these banks classified Kingfisher as an NPA (Non-Performing Asset).
That’s a 4-year delay in recognizing distress that the Z-Score had already flagged.
Possible reasons:
- Kingfisher was a prestigious brand backed by a well-known businessman (Vijay Mallya)
- Banks were reluctant to admit they had made poor lending decisions
- There was hope that business would improve and the airline would turn around
- Senior management and promoter credibility masked financial weakness
The DHFL Story:
Credit rating agencies gave DHFL high ratings.
- A- grade long-term and
- A+ short-term ratings.
These rating were ket like that right up until early 2019.
Yet, the Z-Score would have shown distress. Why?
- Rating agencies were caught off guard by the IL&FS collapse, losing credibility
- DHFL was an established player with 35 years of history
- Short-term liquidity crises are different from bankruptcy – rating agencies didn’t fully account for the asset-liability mismatch risk
- The fraud allegations came as a shock – something not visible in historical financial data
What’s The Lessons for we Investors?
If you’re investing in companies (stocks), here are the practical takeaways:
- Use the Z-Score but Don’t Rely Solely on It: The Z-Score is a useful red flag, but it’s not foolproof. Use it alongside other analysis. You need to look at the quality of management, industry trends, competitive position, and governance.
- Negative Working Capital is a Major Warning: If a company has been burning through working capital for more than one year, be very cautious. Both Kingfisher and DHFL showed this problem years before collapse.
- Retained Earnings Matter: A company with accumulated losses is vulnerable. It has no profit buffer to survive a crisis. Check if the company is actually making money over many years, not just one or two quarters.
- Watch for Liquidity Mismatches: If an NBFC or bank is borrowing short-term to lend long-term, and the cost of borrowing is rising, it’s in trouble. But how to identify this issue? There are three ways to do it:
- First, check the Balance Sheet. Compare the “Liabilities” section to see what portion is due within one year (short-term) versus what’s due after one year (long-term). Then compare this to the “Assets” section to see how much of the loans are long-term.
- Second, look at the Cash Flow Statement. If you see large amounts of money coming in from short-term borrowing (commercial papers, inter-corporate deposits) but going out as long-term loans, that’s a red flag for asset-liability mismatch.
- A simpler way: Calculate the ratio of Short-term Liabilities / Long-term Assets. If this ratio is high (above 0.8-1.0), the company is borrowing short-term to fund long-term lending, which is risky. This was the problem with DHFL, but it only became acute after IL&FS crisis increased borrowing costs.
- Beware of Asset-Heavy, Cash-Poor Situations: Kingfisher had aircraft (assets) but negative cash flow. DHFL had a large loan book but couldn’t collect money and couldn’t refinance. Assets don’t mean safety if they can’t generate cash.
- Regulatory and Peer Action is Important: When you see that regulators are getting worried (like when RBI steps in), it is a danger sign. We must also keep an eye on the peers. When peers in the sector are getting downgraded simultaneously, treat it as a major warning sign.
Conclusion
The Altman Z-Score did successfully predict both Kingfisher and DHFL’s bankruptcies.
- Kingfisher’s score of -3.43 was a clear screaming red alert from 2008 onwards.
- DHFL’s score of 0.625 in 2019 was similarly alarming.
What does it mean? The Altman Z-Score model worked.
But the real lesson for investors is this something else. Knowing that a company is going to fail is only half the battle. You also need to understand when it will fail. You must know when to bail-out before its too late.
The Z-Score is a useful tool for your investment analysis. Both Kingfisher and DHFL investors and lenders would have benefited immensely if they had paid attention to these early warning signals.
